UniCredit SpA (UCG IM) ... A European recovery story?

Wednesday 31st July 2013

I read this morning that Goldman Sachs Asset Management (GSAM) has significantly increased its exposure to European equities (Goldman bets on Eurozone recovery). Their belief is that the European recession is about to end. They may have a point. Having been in the doldrums for over two years, the German, French and Italian manufacturing purchasing managers indices (PMIs) are on the cusp of signalling expansion. As far as economic surveys go, there is no better indicator than the PMIs. The German and French service PMIs are also on the up. Germany, France and Italy is c. 75% of the Euro Area, which is all that counts. Two years in contraction is a long time. 

Improving economies means less insolvencies, which should equate to less impairments for the banking sector. Just look at how that has benefited the UK and Irish banks this past year. The share prices of Lloyds, Barclays, RBS and Bank of Ireland have each more or less doubled over twelve months.

Price to book ratios have improved. According to Bloomberg, Lloyds is now priced at 1.1x book, as compared to less than 0.5x in early 2012. Bank of Ireland, would still appear cheap at 0.5x. I have already bought some Bank of Ireland.

With Europe possibly on the mend, and clear evidence of how an improving economy has impacted the UK and Irish banking sectors, I've taken a speculative position in UniCredit (UCG IM, mkt cap €23.7bn) at €4.10/shr. However, cognisant of the fact that Europe has a history of presenting false dawns and that the representations of all these banks’ capital adequacy may be complete hokum, via ETX I've hedged with €4 September puts at a cost of 17 €cents/shr. My instinct is that UCG will move higher relatively quickly on improving economics; I'm targeting €5.5/shr. With the puts, I reckon I've risked €1 to win €4. I think the odds should be better than that. Bloomberg suggests that UCG trades on 0.38x book value. A 0.5x multiple would roughly sit with my expectation of €5.5/shr. 

Germany, France, Italy - manufacturing Purchasing Managers Indices
Source: Markit, Bloomberg

Germany, France, Italy - service Purchasing Managers Indices
Source: Markit, Bloomberg

LLOY, BARC, RBS, BKIR - 12 month share price performance
Source: Bloomberg

Price to book ratios - UCG, LLOY, BARC, RBS, BKIR
Source: Bloomberg

UniCredit - share price
Source: Bloomberg

Disclaimer: The information, discussions or topics referred to on this blog should in no way be considered “advice” to buy or sell anything. The information which may be referred to is freely available in the public domain and where required the source of information is referenced to for verification. While every effort has been made to ensure the veracity of any information contained within this blog, the author accepts no responsibility for the accuracy of any information contained within this blog or for the sources of information which may be referred to. Readers are responsible for their own actions and interpretation of the information contained within this blog. 

Euro Bund ... Heresy to the monetarist Taliban

Tuesday 23rd July 2013

I’ve closed my US long bond short (When QE stops the long bond drops). It probably goes lower, but I reckon Bunds fall more precipitously from these levels. So yesterday I called up Jackie at ETX and shorted the German long bond, i.e. the Euro Bund Future at €144.20. The €144.20 implies that 10 year Bunds yield 1.26% pa. It would appear the lowest it has ever yielded since 1990 is 1.07%. That was in April last and corresponded to a price of €147.20. Therefore, €147.20 is probably about as high as it can go.

  

My reasons for shorting are as follows:

• I reckon it inconceivable that the monetarist Taliban, otherwise known as the Bundesbank (BUBA), will permit long-term interest rates to reside at c. 1% for 10 years. However, it should be noted that they have allowed rates to be between 1-1.5% since mid-2012. How much longer before the BUBA says enough is enough I do not know, but I doubt it is 10, 8, 5, or even maybe just one more year.
  
  
• The spread between German and US ten year notes is the widest it has been for 30 years. US Treasuries yield 2.85% while German Bunds yield 1.26%. Not that I wish to own either, but if I were a buyer I would much prefer 2.85% to 1.26%. Particularly as there is a risk that Germany may at some stage have to assume peripheral debt.
  
  
• I suppose that the euro could appreciate against the dollar to mitigate the spread in yields, but as US interest rates are rising (and euro rates currently not) the dollar is likely only to get stronger. That makes holding US assets more attractive than low yielding euro's. On the other hand, were euro to strengthen, then one would imagine that precedes rising euro rates, which will kill off sub 2% yields. 
  
  
• The ECB could print money and embark on its own QE, but that would be anathema to BUBA philosophy and likely lead to the breakup of the euro. I would imagine that short-term, Bunds may rally although then plummet as the BUBA gets back to business as usual, post its recent disastrous venture into monetary union. 
  
  
• Finally, in technical terms, it appears weak. The price fell below the 200d ma in late May and has recovered over July. But a further, more severe leg down looks to be on the cards. 

In summary:

I reckon I'm looking at up to €3 loss on selling the Bund as compared to €8 or more gain should long-term rates head back to c. 2% or possibly higher. However, should I find myself down the €3, I would probably be inclined to double up. Do I think the monetarist Taliban will permit long-term rates to indefinitely be this low? Nein! 

RX1 Comdty - Generic Euro Bund
Source: Bloomberg

Yield on Generic Euro Bund
Source: Bloomberg

Yield spread against US Treasuries
Source: Bloomberg

Disclaimer: The information, discussions or topics referred to on this blog should in no way be considered “advice” to buy or sell anything. The information which may be referred to is freely available in the public domain and where required the source of information is referenced to for verification. While every effort has been made to ensure the veracity of any information contained within this blog, the author accepts no responsibility for the accuracy of any information contained within this blog or for the sources of information which may be referred to. Readers are responsible for their own actions and interpretation of the information contained within this blog. 

Premier Farnell (PFL) ... Empirical regularity?

Monday 15th July

I am long Premier Farnell (PFL, mkt cap £813m) from 218p/shr for what I reckon could be a smash n’ grab. That is to say that at the outset I did not plan on holding for a prolonged period, just that I project an appealing pop higher in a short space of time. I expect PFL’s peer, Electrocomponents’ (ECM, mkt cap £1,103m) trading update this Wednesday to be the catalyst. Ex-post, I reserve the right to ride any bounce for longer than I’d planned.

What initially caught my eye was empirical regularity (ER). ER is not an iron law but it’s a hard trend to break. Historically, PFL’s share price (and ECM’s) has strongly correlated with that of the performance of the US Philadelphia Semiconductor Index (SOX Index).  According to Bloomberg, the US SOX is a “modified capitalisation-weighted index, comprised of companies that are involved in the design, distribution, manufacture, and sale of semiconductors.” As PFL and ECM distribute electronic components, it's hardly surprising that over the course of many years, their share prices have correlated well with this index. However, more recently this trend has faltered somewhat. I am predicting that ER resumes. 

On a currency-adjusted basis, PFL has significantly underperformed the SOX during the past 12 months. The last periods of significant under-performance were in 2005 and 2011, when PFL rallied from the 160s to the 210s and from the 180s to the 220s, respectively. Given where the US SOX is currently at, and the empirical regularity with which it has led the component distributors, I reckon PFL should be closer to 300p/shr and not 220p/shr (36% upside). As such there’s probably a decent safety margin on being long PFL.

Further encouragement is forthcoming from the boffins at the Semiconductor Industry Association (SIA). The SIA report that semiconductor billings jumped 4.6% higher during May 2013. That was the largest sequential monthly increase in sales for the industry in over 3 years. Three-month-moving average sales were 6.3% higher so it wasn't a flash in the pan. Moreover, the Global manufacturing PMIs have also been on an improving trend over recent months.

Electrocomponents reports its 1Q14 trading update this Wednesday 17th July. Comps are relatively undemanding with 0% organic growth achieved in 1Q14, so there is likely some scope for a positive update and read across to PFL.

On a valuation basis, PFL trades at 12x next year’s earnings (Bloomberg consensus). That doesn’t appear expensive when considering that EPS growth is projected to be well into double digits over the forecast horizon. PFL also yields 5% on the dividend.

And another thing ...

I could always have just bought ECM instead. But it’s the chart of PFL which also appeals to the gambler in me. As far as my amateur charting skills can infer, PFL appears to be on the verge of a bull flag breakout.

Empirical regularity; strengthening markets; operational gearing; appealing valuation; attractive dividend; bull flag breakout opp ... Phwoar!!!  I’ve bought a fair few. 

Premier Farnell (PFL) share price vs. US Philadelphia Semiconductor Index (SOX)
Source: Bloomberg

Global manufacturing surveys
Source: Bloomberg

PFL share price - potential bull flag breakout?
Source: Bloomberg

Disclaimer: The information, discussions or topics referred to on this blog should in no way be considered “advice” to buy or sell anything. The information which may be referred to is freely available in the public domain and where required the source of information is referenced to for verification. While every effort has been made to ensure the veracity of any information contained within this blog, the author accepts no responsibility for the accuracy of any information contained within this blog or for the sources of information which may be referred to. Readers are responsible for their own actions and interpretation of the information contained within this blog. 

Avanti (AVN) ... palm to forehead (THWACK!)

Wednesday 10th July 2013

Palm to forehead (THWACK) this morning for holders of Avanti Communications. 

U woz warned ... Prior AVN blogs

As of yesterday, Bloomberg consensus had £31.5m of revenue pencilled in for FY 2013. This morning, Avanti indicated that its actual revenue would “... likely be up to £10m below previous market consensus.” I.e., around £21.5m. It’s worth bearing in mind that consensus forecast 2013 revenue has been on a downward trajectory for some time. Back in 2010, analysts had projected up to £124m for FY 2013 revenue. In 2011 it was pared down to c. £92m. Lower still in 2012 to c. £54m. And analysts started this year forecasting c. £34m for FY 2013 revenue.

The garden path appears to begin with the company’s reported order backlog. In its last interims (12 Feb 2013), the backlog of firm orders was reported to be £290m. Today’s trading update suggests these orders are somewhat less firm. The group’s backlog over the next three years now stands at:

FYE June 2014: £42m

FYE June 2015: £46m

FYE June 2016: £40m

This implies that £162m or 56% of the prior firm backlog is now expected to commence from mid 2016. Given the poor revenue path to 2013, I would question the quality of that £162m.

AVN’s net debt position has worsened. The group had net debt of £141.5m as at 31 Dec 2012. This has risen to what would appear to be £167m by 30 June 2013. The company’s comment that it was “... operating cash flow positive in June” appears to be obfuscation. On the whole, the company still burnt through £25.5m in six months.

I would be happy to sell AVN at anything above £1/shr. Which is what I plan on doing.

And another thing ...
Anyone highlighting that the group has a net asset value (NAV) of £253m and therefore draws the conclusion that this is what the business should be valued at as a minimum is misguided. Firstly, that NAV appears to be dwindling. Secondly, the group continues to burn through tremendous levels of cash, has a poor record of meeting sales projections, and to me appears to have a peculiar approach to qualifying its trade receivables. Finally, in the event that the business were ever to cease to be a going concern, then the debt holders would claim first dibs over the tangible assets, which make up the rump of the NAV. 

Avanti share price
Source: Bloomberg

Disclaimer: The information, discussions or topics referred to on this blog should in no way be considered “advice” to buy or sell anything. The information which may be referred to is freely available in the public domain and where required the source of information is referenced to for verification. While every effort has been made to ensure the veracity of any information contained within this blog, the author accepts no responsibility for the accuracy of any information contained within this blog or for the sources of information which may be referred to. Readers are responsible for their own actions and interpretation of the information contained within this blog. 

Lloyds (LLOY) ... go for launch

Thursday 4th July 2013

Post last Friday’s (28^th June) announcement that UK Financial Investments Ltd has invited banks to apply to manage the sale of the UK Government’s holdings, I've bought quite heavily into Lloyds (LLOY, mkt cap £46bn) at up to 64p/shr.

The UK Government has 39% of LLOY to offload, with a break-even level at 61.2p/shr (this price accounts for the fees already paid by the bank to the authorities for State guarantees). Therefore I reckon the placing gets done at 62p+/shr. There must be no prospect of the UK Government taking a loss and the political/press fallout as a result. This is not a fund raise, it is a placing and the UK Government can afford to wait if needs be. Not that I think it will have to. There is a reason why LLOY was the FTSE’s best performer in 2012 ...

• Well capitalised: LLOY’s management has upgraded its core tier 1 ratio target from greater than 9% by FY2013 and 10% by FY2014 to 10% by FY2013. That makes shareholder returns more likely sooner rather than later. 
• Potential significant shareholder returns: LLOY’s could be capable of returning up to £10bn to shareholders via dividends and share buy backs over the next two years. That would be equivalent to 20%+ of its current market cap. Bloomberg consensus has a cumulative £8.65bn of net income projected for 2014-15. A 35% payout ratio would equate to over £3bn in dividends. Further, any excess capital above management’s 10.5% target, could pave the way for material share buy backs. 
• UK economy appears to be improving: The UK house builders continue to report improved trading and outlooks, while the UK Services PMI has reported its highest measure in over two years. That's likely to improve LLOY’s outlook for net interest margins and capital ratio; the latter supporting share buy backs.

I expect high demand for the UK Government’s stake in LLOY. Sovereign Wealth Funds (SWFs) will likely hoover up all they can get in a placing of a well capitalised bank, active in an oligopolistic market, in an improving economy and with considerable shareholder returns on offer. Further, SWFs are not the type looking for quick turns. They will take a stake and sit on it for years. As soon as the free float is up, then tracker funds will also have to start buying. In short, I would expect buying pressure to overwhelm selling.

Finally, this placing is a big juicy ticket for the Investment Banks. They will be keen to get this done well and demonstrate an ability to do RBS next. No sensible analyst will jeopardize being on the juicy tickets with a SELL note.

Ps. The chart also looks like it’s on the verge of breaking out.  

Lloyds share price
Source: Bloomberg

Disclaimer: The information, discussions or topics referred to on this blog should in no way be considered “advice” to buy or sell anything. The information which may be referred to is freely available in the public domain and where required the source of information is referenced to for verification. While every effort has been made to ensure the veracity of any information contained within this blog, the author accepts no responsibility for the accuracy of any information contained within this blog or for the sources of information which may be referred to. Readers are responsible for their own actions and interpretation of the information contained within this blog.